Small business ownership is a good way to take more control of your time and puts more money in your pocket. But what is the true cost of small business ownership? Surprisingly, many small business owners are faced with many challenges that may leave them with less time and less money than when they were earning a living working for someone else.
One of the most common mistakes that small business owners make is made within eh first few weeks of starting up their business. Choosing the wrong entity and/or business structure can severely hurt a small business trying to get on its feet. While each state is different, the common types of business structures are: sole proprietorship, partnership, limited liability company, and corporation (C and S are the most common). It is important to understand who the structuring of your business will affect your tax situation, how you raise money, the paperwork that is needed to be field, as well as your own personal liability requirements.
A sole proprietorship is the easiest to form and gives you complete control over how the business is run. In most cases, you are automatically considered a sole proprietorship is you perform business activities and do not register as any other type of business. Sole proprietorships report their taxes on the owner’s personal Federal Form 1040 tax return. They are also subject to self-employment taxes, and the owner cannot take a W2 wage. As they are not seen as separate from the owner, all assets and liabilities are also not separate from the owner, and you may be held personally liable for any debt and obligation incurred on behalf of the business. Sole proprietorships are considered low risk, and a good place for owners looking to start out before creating any more formalized business.
Partnerships are the simplest structure for two or more owners to do business together. There are two common types of partnerships: limited partnerships and limited liability partnerships. With a limited partnership, there can be only one general partner and the rest are limited liability partners. The limited liability partners also have limited control over the company and its decisions. Profits and losses are passed through to the general partner to report on their personal Federal Form 1040, and any profit is subject to self-employment taxes. The limited liability partners only pay self-employment on any guaranteed payments they receive. In the limited liability partnership, the liability is limited to each owner. This protects all partners from debts against the partnership and the actions of the other partners.
A limited liability company gives the small business owner the benefit of both the corporation and partnership structure. Limited Liability Companies are designed to protect the owner(s) from personal liability, thereby protecting their assets from lawsuits or debt created in the business. The profits and losses are passed through to the owner’s personal Federal Form 1040 for taxation. They are, however, considered to be subject to self-employment taxes. Each state has different rules regarding the treatment of limited liability companies, so it is important to determine I the regulations of your state will work for your business.
A C Corporation is a legal entity completely separated from its owners. As a separated entity, it is responsible for its own taxes as well as legal liability. While this structure provides the most legal protection for the owner, there is also the greatest cost to set up a C Corporation. They also require the most amount of record keeping, operational process and reporting. Additionally, they are subject to double taxation. The profits are first taxed on the corporate level, and then the dividends paid to each owner is taxes on the owner’s personal Federal Form 1040 return. If an owner chooses to leave the Corporation, he/her shares are simply sold, and the Corporation feels little to no affect. Raising funds can also be easier, as the Corporation can sell stock.
Sub Chapter S Corporations are designed to avoid the double taxation that occurs in the more traditional C Corporation. The S Corporation allows for profits and losses to be passed directly to the owner’s or owners’ personal Federal Form 1040 for taxation purposes without being subject to self-employment taxes. Again, each state has different regulations when it comes to the treatment of S Corporations, and so it is important to understand your own states stance. The S Corporation is limited in its shareholders to one hundred, and they must all be US Citizens. It also retains the strict processes and operations reporting that a C Corporation has. And like a C Corporation, it is easy for a shareholder to leave the company.
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